Let's begin our discussion by getting into the mindset of a business. Now, if you are thinking like a business, you must decide the following:
In order to produce, businesses must purchase resources, also known as factors of production by economists. Factors of production are the resources defined as land, labor, and capital that are necessary to produce output for the sake of profit.
Clearly, land itself is included in this category. Most businesses have to purchase at least a little bit of land in order to have a place to do their business.
However, land also includes anything that comes from the land, such as wildlife, fertile soil, minerals, and timber.
EXAMPLEExamples of people laboring would include doctors and nurses, teachers, hairstylists, and cashiers.
A person can be producing either a physical good or providing a service and be considered labor.
EXAMPLEExample of capital are buildings, computers, and roads.
So, how do firms decide how much land, labor, and capital they need to purchase? Well, it involves a couple of factors.
The first factor is that they have to figure out how much they are producing. This decision might change vastly if they are producing a lot versus a small amount.
In addition, the price or cost of each factor of production or resource plays a major role.
The goal of any business is cost minimization, or selecting the output strategy that incurs the least amount of cost, that will lead a business to profit maximization, which is the procedure of determining quantity and cost that yields the greatest profit.
Now, sometimes it is helpful to compare firms to consumers. Whereas we as consumers seek to maximize our utility or our satisfaction when making purchases, firms seek to maximize their profit.
Consumers base their buying decisions on individual preferences, while firms base their decisions on the opportunity costs.
|Consumers Maximize Utility||Firms Maximize Profit|
|Based on individual preferences||Based on opportunity costs of land, labor, and capital|
We all face constraints--and businesses are no exception. A constraint is an element that interrupts production of a firm or consumption by individuals.
In this tutorial, we are focusing on the production of the firm, so whereas consumers are constrained by time and income, businesses are additionally constrained by their factors of production.
Land, labor, and capital are definitely limited in the world, and are therefore constraints.
Let's begin our discussion about the short run versus the long run with an example.
Several Christmas seasons ago, a child's toy called Tickle Me Elmo was all the rage. In fact, mothers and fathers could not get their hands on this doll for their kids. Business was certainly booming!
If you were the owner of that business, wouldn't you want to produce more in order to make a greater profit? Clearly, consumers everywhere were willing to pay outrageous amounts of money for this doll.
Therefore, as the business owner, you'd want to produce more so that you can make that profit. However, firms are constrained by their resources, and it varies in the short run versus the long run.
However, in the short run, you are limited. You might not have enough workspace or enough capital, like machines.
Therefore, you can hire all the workers you want, and buy all the material you want, but your workers will likely get in one another's way, and won't have enough machines to work on. It won't be enough to justify the additional workers that you hired.
Certainly, there is some wiggle room in the short run, and you will simply optimize your capabilities and do the best with what you have.
However, there is something called short-run constraints, which is a temporary period of time with least control over constraints when at least one element is fixed.
EXAMPLEFor example, you can't simply terminate your lease and buy a new building in the short run, because you have a contract or lease agreement for a designated period of time. This is what we mean by a fixed element.
In this example, though, within a year, you can:
Since you have the time to investigate different opportunities and raise the capital needed for them, the possibilities are endless in the long run.
Here is a brief summary of short run versus long run.
|Short Run||Long Run|
|At least one cost is fixed||All costs become variable|
|Example: Rent||Example: I can terminate my lease|
Now, it is important to note that even though this is how we define short run versus long run, it is worth questioning if everything is actually variable in the long run.
In theory, the constraint of having a fixed cost disappears in the long run, for instance:
However, what you need to keep in mind is that the long run is really the sum of all of your short-run decisions. Therefore, in the short run, you have already optimized your production abilities each and every time.
Source: Adapted from Sophia instructor Kate Eskra.